When the stock market is in the middle of a panic, investors flee to bonds. Last week, that fundamental “flight to safety” approach didn’t work. A surge in U.S. treasury bond yields sparked questions about the fundamental role of bonds in a diversified portfolio, and even bigger questions about whether an unprecedented shift away from the U.S. treasuries market and U.S. dollar could be underway.
Managing bond maturities had already become increasingly difficult for investors in a world of rapid interest rate swings and inflation as the Fed transitioned from an era of ultra-low interest rates to major rate hikes to fight inflation. Many have opted to only invest in ultrashort treasury bond funds to avoid the risk. But there’s another concept used by financial advisors and wealth planning firms for decades that investing experts say can work for investors seeking shelter in the market storm that has hit both stocks and bonds as a result of President Trump’s trade war: the bond ladder.
Experts say that in today’s volatile atmosphere, this concept has the potential to offer exposure to treasury bonds without having to worry about massive short-term swings in prices and yields. The goal of a bond ladder is to invest in a wide range of treasury maturities, hold them all to maturity, and provide regular income, in the form of principal and interest, on a monthly basis.
Many financial advisors and wealth management firms continue to offer this strategy on a custom basis, but it is a lot of work and often reserved for high net worth clients.
The LifeX 2035 Term Income ETF (LDDR) brings the same approach into an ETF at a reasonable cost (an expense ratio of 0.25%, or 25 basis points), investing in treasuries, from 30-day issues to 10-year bonds, and has a fixed monthly income distributing roughly 11% to investors, through 2035. In a sense, for investors familiar with the target-date fund approach that is timed to invest in a manner that meets the life needs of an investor as they age, and who also understand the concept of annuities, this bond ladder ETF brings similar approaches to fixed-income personal finance. It provides monthly income with a decades-long horizon.
“When you buy a bond you know exactly what you’re going to get,” Nate Conrad, head of the LifeX mutual fund franchise at Stone Ridge Asset Management, said on CNBC’s “ETF Edge” last Wednesday. “When you create a bond ladder, you don’t care about these changes that we’re seeing in bond prices because you’re going to get what you’re going to get,” he said.
Independent ETF expert Dave Nadig says the bond ladder strategy is a safe bet in an agitated bond market because even as treasury prices and yields swing, it should not matter to the investor holding this kind of fund for regular income needs.
“You need to understand that when things happen like what’s going on in the market right now where we have the bond market selloff, the net asset value of these is going to come down and that’s going to be a shocker,” Nadig said. “That’s completely normal and you should not care because the point of this is holding it to completion, holding it to maturity. … They are, to be blunt, very boring in construction, and I’m a big fan of boring when it’s delivering an actual pattern of returns that investors need.”
“When you create a ladder, you don’t care about the prices,” Conrad said. What you do care about, he said: “Peace of mind in a really tough time.”
Most investors have opted for another approach to dealing with the recent bond market stress, leaning on ultrashort fixed-income bond ETFs. Mike Akins, founding partner at ETF Action, says ultrashort ETFs have become akin to money market funds for some investors.
“Ultrashort is far and away where you’re getting most of the money,” Akins said, with the recent data showing over 90% of bond ETF flows into the ultrashort category, which includes the iShares 0-3 Month Treasury Bond ETF (SGOV) and SPDR Bloomberg 1-3 Month T-Bill ETF (BIL).
But Nadig says the bond ladder can serve a broader goal. “It’s really about protecting the buying power here,” he said. “This is about immunization from liabilities,” he added. For any investor worried about mortgages, second properties, and college payments, “you take that cash flow and put it out of mind. It’s a psychological tool. It’s much easier to let it ride when you know how it will play out,” he said.
Of course, no strategy is entirely without risk. In a world of hyper-inflation, there is no way to guarantee any investment can preserve buying power. And after a week during which investors seemed to question whether the U.S. bond market would continue to serve in its long-time role as the surest investment in the world, there is no ruling out the unthinkable, even if it does remain an unlikely outcome.
A U.S. treasury default is the only other reason to worry about a bond ladder strategy.
“God willing, we’re in that world where you’re never going to see that,” Nadig said.
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